LDI Quarterly Update: 1Q24

LDI Quarterly Update: 1Q24

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Most U.S. plans are now 110% funded. Pivoting to cash flow driven investing can reduce admin costs while better managing liquidity needs.

U.S. pension plans’ funded status rises further, to 110%
Illustration for a 50/50 fixed income/equity portfolio with a duration of 12
As of 3/31/24. Source: S&P, FYE 2022 company reports, Voya IM calculations and 2023 estimates. 1 Growth assets based on S&P 500 return of 11%; hedging assets (which match liability duration) had a 3% loss, similar to liabilities, by design, also reflecting benefit payments. . 2 Liabilities decreased 3% due to 29 bp increase in rates and plan duration of 12 years, based on the FTSE pension discount curve, further adjusted for service accruals and benefits payments.

As of 3/31/24. Source: S&P, FYE 2022 company reports, Voya IM calculations and 2023 estimates. 

1 Growth assets based on S&P 500 return of 11%; hedging assets (which match liability duration) had a 3% loss, similar to liabilities, by design, also reflecting benefit payments.

  2 Liabilities decreased 3% due to 29 bp increase in rates and plan duration of 12 years, based on the FTSE pension discount curve, further adjusted for service accruals and benefits payments.

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As of 3/31/24. Source: S&P, FYE 2022 company reports, Voya IM calculations, 2023 and 2024 estimates.

In the spotlight: The re-emergence of cash flow driven investing

CDI: An efficient way to manage liquidity needs for overfunded plans too

As plans continue to benefit from improved funded levels and increased allocations to lower-risk assets, cash flow driven investing (CDI) has re-emerged as a strategy that can help ensure liquidity needs are met efficiently.

Typically, CDI is implemented when sponsors find themselves in a negative cash flow position—when their benefit payments and expenses exceed their contributions, and their ability to make timely payments takes precedence over their need for long-term equity returns.

CDI was implemented in this context to secure front-end benefit payments, with carefully laddered and earmarked assets that mature and match benefit payments plus expenses as they come due. This allowed sponsors to risk up the remaining assets in underfunded plans as a strategy to close a deficit.

However, with plans finding themselves fully funded recently, the ever-increasing allocations to hedging assets have created a concern around selling out of those assets to cover benefit payments. This has resulted in a re-examination of CDI as a strategy that ensures assets mature concurrently with benefit payments and expenses as they come due. Put simply, it’s a way to efficiently manage liquidity needs. CDI is also especially advantageous in a time of elevated rates and an inverted yield curve, such as our current market environment. Sponsors can now meet the benefit payments and expenses organically with short duration high yield (but still investment grade) fixed income assets, which require less up-front funding than when rates are lower.

Voya’s approach to CDI

The key to successful CDI is a careful selection of fixed income instruments that considers the timing of coupon payments and maturities that are used to match the liability cash flows.

These assets are often held to maturity to capture certainty and clip coupons rather than pursuing total returns through active trading. The buy and hold approach provides the stability a sponsor seeks.

With CDI, we endeavor to lower sponsors’ administrative burden, with fewer manager withdrawal requests as well as lower transaction costs.

Typically, we only look within the investment grade ecosystem: Corporate debt, securitized credit rated A or better, and/or commercial mortgage loans. We consider and solve for a positive cumulative surplus at the end of the period.

Notes on the quarter

  • The first quarter of 2024 posted another significant improvement in funded status for corporate U.S. pension plans, in aggregate. At the end of 1Q24, the funded status of extant pension plans in the S&P 500 is 110%, up from from 105% at year end. Funded levels are now higher than they were right before the global financial crisis. 
  • The treasury curve shifted upward during the quarter, with the 10yr UST and 30yr UST yields both increasing 33 bp. 
  • Credit spreads narrowed even more. The net result of rates and spreads was a 29 bp increase in discount rate of in Q1. For a plan with duration 12, this translates to a 3% decrease in liability due to rates during Q1. 
  • U.S. equities had a total return of 11% for the quarter, significantly contributing to the improved funded position.
Markets
Markets

Source: FTSE, Barclays Live, ICE Index Platform, See page 3 for index definitions.

 3 Based on FTSE’s “short” duration plan, approximately 11.1 years.

Spot rate curves
Spot rate curves
  • The US Treasury spot rate curve is flatter than the FTSE pension discount curve as of 3/31/2024. 
  • For the 15-year tenor, the US Treasury spot rate is higher as of 3/31/2024 versus 12/31/2023. 
  • Similarly, for the 15-year tenor, the Aa-rated corporate bond spot rate is higher as of 3/31/2024 versus 12/31/2023.

 

 

A note about risk

Examples of LDI (liability-driven investing) performance included in this material are for illustrative purposes only. Liability valuations can increase due to falling interest rates or credit spreads, among other things, as the present value of future obligations increases with falling rates and falling spreads. Liabilities can also increase due to actual demographic experience differing from expected future experience assumed by the plan’s actuary. Diversification neither assures nor guarantees better absolute performance or relative performance versus a pension plan’s liabilities. In addition, investing in alternative investment products such as derivatives can increase the risk and volatility in an investment portfolio. Because investing involves risk to principal, positive results and the achievement of an investor’s goals are not guaranteed. There are no assurances that any investment strategy will be profitable on an absolute basis or relative to the pension plan’s liabilities. Information contained herein should not be construed as comprehensive investment advice. For comprehensive investment advice, please consult a financial professional.

Past performance is no guarantee of future results. This information is proprietary and cannot be reproduced or distributed. Certain information may be received from sources Voya Investment Management considers reliable; Voya IM does not represent that such information is accurate or complete. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial data. Actual results, performance or events may differ materially from those in such statements. Any opinions, projections, forecasts and forward looking statements presented herein are valid only as of the date of this document and are subject to change. Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information. The opinions, views and information expressed in this presentation regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Portfolio holdings are fluid and are subject to daily change based on market conditions and other factors. 

Canada: This document is private and confidential and only for use by “permitted clients” in Canada. This document is for information purposes only and is not intended as an offer or solicitation to invest. This document does not constitute investment advice and should not be relied upon as such. Voya Investment Management Co. LLC is a non-Canadian company. We are not registered as a dealer or adviser under Canadian securities legislation. We operate in the Provinces of Nova Scotia, Ontario and Manitoba based on the international adviser registration exemption provided in National Instrument 31-103. As such, investors will have more limited rights and recourse than if the investment manager or broker-dealer were registered under applicable Canadian securities laws.

For qualified institutional investor use only. Not for inspection by, distribution to or quotation to the general public.

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